This article is published courtesy of the June 2009 edition of Business Law News, published by the State Bar Business Law Section. The State Bar offers its members the opportunity to network with other lawyers who share a common interest through its 26 sections. Section membership includes access to newsletters, email lists to facilitate information sharing, and other resources.

By Aaron Gary, Wisconsin Legislative Reference Bureau

June 17, 2009 – In the midst of the economic downturn and national focus on alleged lending abuses by banks, credit card issuers have been raising interest rates and fees for many borrowers. In April, President Obama summoned credit card industry representatives to the White House for a summit to address mounting concern over card issuer policies and practices.

The rising chorus for credit card reform is fueled in part by the fact that card issuers’ push for higher interest rates and fees comes at a time when many card issuers are receiving federal “bailout” money and the cost of funds to card issuers is at a historic low. In addition, some consumers have experienced a spike in interest rates and fees despite compliance with their card holders’ agreements. For its part, the credit card industry is facing significant challenges, with consumer delinquencies at an all-time high and significant illiquidity in the secondary market for credit card debt (about half of the nation’s credit card debt is securitized and sold to investors in the secondary market, and many fear a meltdown in this market that will parallel the subprime mortgage meltdown).¹

This article examines the legal framework in which credit card interest rates and fees must be examined, pending federal legislation, and the impediments to effective state regulation.

Usury law applicable to financial institutions

National banks. Many aspects of national bank operations are entirely immune from state regulatory efforts, but setting loan interest rates and fees is not one of them. States may limit the interest rates and fees that national banks organized in the state may charge on open-end credit such as credit cards.

Under sections 85 and 86 of the National Bank Act (NBA),² a national bank may charge the higher of the interest rate allowed by state law “where the bank is located” or 1 percent over the local Federal Reserve Bank’s discount rate on 90-day commercial paper.³ In Marquette National Bank v. First of Omaha,⁴ the U.S. Supreme Court determined that, for purposes of section 85, a national bank is located in its home state as identified in its charter, not in the state where the borrower resides. The Court held that a national bank may charge its out-of-state credit card customers any rate of interest allowed in the national bank’s home state even if that rate is considered usurious under the law of the state where the card holder resides.⁵ This is referred to as a national bank’s right to export interest rates from its home state.⁶

For purposes of section 85, interest has an expansive meaning that encompasses any payment that compensates the creditor for the extension of credit or for breach of the credit terms, including late payment fees, overlimit fees, annual fees, and cash advance fees.⁷ Thus, the national bank in Smiley, whose home state was South Dakota, could charge its credit card customers residing in California late payment fees allowed under South Dakota law but impermissible under California law.⁸

Out-of-state state banks. In the late 1970s, as inflation soared and the cost of funds to financial institutions rose, many state-chartered financial institutions were limited by state usury laws in the rate of interest they could charge on loans. In states with low interest rate ceilings, financial institutions had difficulty achieving acceptable returns on investment, given the high cost of funds, resulting in a credit crisis in these states. National banks, able to rise with the inflationary tide, were not subject to the same limitations and gained a competitive economic advantage over their state-chartered counterparts.

In response to these circumstances, Congress passed the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDA),⁹ which was intended to prevent discrimination against state-chartered banks and to level the economic playing field between national banks and federally-insured state banks. (All state banks chartered in Wisconsin are federally insured.)¹⁰ Section 521 of DIDA (also sometimes referred to as section 27 of the Federal Deposit Insurance Act (FDIA)), created an interest rate provision applicable to federally-insured state banks, defined broadly under the FDIA, that mimics the language of NBA section 85 applicable to national banks.¹¹ Courts have determined that this DIDA provision should be given an interpretation parallel to NBA section 85. That is, a federally-insured state bank may export credit card interest rates and fees to out-of-state card holders if the interest rates and fees are allowed in the state bank’s home state, even if they are not permissible in the state of the card holder’s residence.¹² However, as discussed below, DIDA section 521 differs from NBA section 85 in that states may opt out of this DIDA provision.

Savings associations and credit unions. DIDA applies not just to federally-insured state-chartered banks, but also to savings associations and credit unions that are federally-chartered or state-chartered and federally-insured. DIDA sections 522 (savings associations) and 523 (credit unions) are virtually identical to DIDA section 521 and also mimic the language of NBA section 85.¹³ Accordingly, federally-chartered and federally-insured state-chartered savings associations and credit unions may export credit card interest rates and fees to out-of-state card holders if the interest rates and fees are allowed in their home states.¹⁴ However, there are two caveats. First, DIDA sections 522 and 523 are subject to the opt-out provision discussed below. Second, under the Federal Credit Union Act (FCUA),¹⁵ federal credit unions are granted the power to make loans subject to National Credit Union Administration (NCUA) regulations but may not charge an annual interest rate exceeding 15 percent unless the NCUA authorizes a higher interest rate.¹⁶

DIDA’s opt-out provision. Section 525 of DIDA allows states to reject the federal preemption of state interest rate regulation offered by DIDA sections 521 to 523 by adopting a law that “states explicitly and by its terms that such State does not want” these provisions of DIDA to apply in the state.¹⁷ Wisconsin elected to opt out of DIDA sections 521 to 523, effective Nov. 1, 1981.¹⁸ Accordingly, beginning on this date, federally-insured state-chartered banks, savings associations, and credit unions organized in other states could not export credit card interest rates and fees into Wisconsin. (It is unclear how section 525 was intended to affect federally-chartered savings associations and credit unions.) Wisconsin later reversed course. In 1997 Wisconsin Act 142, effective May 5, 1998, Wisconsin attempted to repeal its prior rejection of DIDA. It is questionable whether, once Wisconsin rejected DIDA preemption in 1981, it could revive that preemption in 1998.

The federal Truth in Lending Act

The Truth in Lending Act (TILA),¹⁹ and Regulation Z (Reg. Z) promulgated under TILA by the Board of Governors of the Federal Reserve System (Federal Reserve),²⁰ generally govern consumer disclosures and credit practices. One of the stated purposes of TILA is to protect consumers against unfair credit card practices.²¹ Certain provisions of TILA apply to consumer credit transactions, including those using credit cards, and other provisions apply specifically to credit cards, even with respect to transactions that would otherwise be exempt under TILA. TILA and Reg. Z govern such issues as credit card issuance and advertising, required consumer disclosures, account statements, finance charge computations, billing practices and error resolution, and card holder liability.²² TILA and Reg. Z include narrow preemption provisions, basically preempting state law only where there is an inconsistency with federal law.²³ TILA and Reg. Z do not establish a national usury standard.

Pending federal legislation

Numerous proposals have been introduced so far in the 111th Congress attempting to curb perceived unfair practices by credit card issuers. These proposals, each of which would amend TILA, include the following:

• H.R. 627 includes changes relating to account practices and consumer options and restricts issuance of cards to underage consumers.

• H.R. 1608 and S. 500 override other federal law to establish a national usury rate (interest and fees) for consumer credit transactions of 36 percent.

• H.R. 1640 and S. 582 override other federal law to establish a national usury rate (on unpaid balances) for consumer credit transactions of 15 percent.

• S. 255 overrides other federal law to limit interest rates and fees applicable in consumer credit transactions to those permitted under state law where the consumer resides.

• S. 392 includes changes similar to H.R. 627 and S. 414.

• S. 414 includes changes similar to H.R. 627 but is more comprehensive and also includes consumer disclosures.

H.R. 627 and S. 414 have emerged as the front-runners; each has passed committee and seems to be generally supported by the President.²⁴ H.R. 627 passed the House on April 30, 2009, with amendments requested by the Obama administration.²⁵ Both H.R. 627 and S. 414 focus on credit card issuer practices, rather than establishing a national usury rate for credit cards or authorizing states to impose usury rates on federally-chartered financial institutions. These two bills, H.R. 627 in particular, are quite similar to federal regulations already set to take effect on July 1, 2010.²⁶ (Update: H.R. 627 was signed by the President as P.L. 111-024 on May 22, 2009.)

Impediments to Wisconsin legislation

Effective May 17, 1996, Wisconsin eliminated interest rate and fee limits for open-end credit transactions, such as credit cards, and also specified that such fees are interest for purposes of the NBA and DIDA.²⁷ The stated purpose of this legislation was to enable Wisconsin-based creditors to compete with out-of-state creditors, who take advantage of federal law to charge interest rates and fees allowed by their home states to Wisconsin residents.²⁸

Having repealed its usury law in 1996, Wisconsin could decide to reinstate it, particularly if Wisconsin policymakers believe that efforts on the federal level for credit card reform have not gone far enough. Wisconsin could enact a new usury law limiting the interest rates and fees charged by credit card issuers and the law would be effective against all of the following: state banks, savings banks, savings and loan associations, and credit unions chartered in Wisconsin; national banks with a home state of Wisconsin; and out-of-state state-chartered banks, savings associations, and credit unions. However, Wisconsin’s usury law would not be enforceable against out-of-state national banks and out-of-state federally-chartered savings associations and credit unions that issue credit cards to Wisconsin residents. National banks located in states such as South Dakota, Nevada, and Delaware, where there is no interest rate limit, may charge Wisconsin residents any interest rate on the credit cards issued by these banks regardless of Wisconsin law.

At the end of 2002, national banks held almost 75 percent of all credit card debt in the United States.²⁹ Following the Marquette decision, major credit card issuers migrated from states with restrictive usury laws to states with lenient or no usury laws.³⁰ As a result, in 2003, national banks located in six states with favorable usury laws originated more than 70 percent of the nation’s credit card debt.³¹ A more recent study concluded that the top 12 credit card issuers hold about 88 percent of the national market share for credit card debt. The Office of the Comptroller of the Currency’s Web site includes a list of national banks and their home states, and it appears that most or all of the top issuers of credit cards are national banks located in states with no interest rate limit on credit cards.

Accordingly, legislation in Wisconsin to limit credit card interest rates and fees is likely to have little impact on the practices of major credit card issuers and is unlikely to assist most Wisconsin credit card holders. For Wisconsin legislation to have a meaningful impact, there would need to be changes in federal law or a uniform act adopted by all states establishing a national limit for interest rates and fees on credit cards.

Endnotes

¹See Stephen Labaton, Obama Pressures Credit Card Issuers on Rates, N.Y. Times, April 24, 2009; Editorial, The Credit Card Trap, N.Y. Times, April 6, 2009; Lisa Lerer, Credit Companies Brace for W.H. Visit, Politico, April 23, 2009; Taking a Look at Credit Card Trends, NPR’s All Things Considered, April 22, 2009.
²12 U.S.C. § 21 et seq.
³See 12 U.S.C. §§ 85 and 86.
⁴439 U.S. 299, 99 S. Ct. 540, 58 L. Ed. 2d 534 (1978).
⁵See Marquette, 99 S. Ct. at 542, 548.
⁶Id. at 548, 550.
⁷Smiley v. Citibank, 517 U.S. 735, 116 S. Ct. 1730, 1732-33, 1736, 135 L. Ed. 25 (1996).
⁸Smiley, 116 S. Ct. at 1735-36. See also Beneficial Nat’l Bank v. Anderson, 539 U.S. 1, 123 S. Ct. 2058, 2061, 2063-64, 156 L. Ed. 2d 1 (2003); 12 C.F.R. § 7.4001 (2009).
⁹P.L. 96-221, 94 Stat. 132 (1980).
¹⁰See Greenwood Trust Co. v. Com. of Mass., 971 F.2d 818, 826-30 (1st Cir. 1992). See also Grunbeck v. Dime Sav. Bank, 74 F.3d 331, 338-40 (1st Cir. 1996); Gavey Properties v. First Financial, 845 F.2d 519, 521 (5th Cir. 1988).
¹¹See 12 U.S.C. §§ 1813 (a) (2), 1831d. See also 94 Stat. at 164-65.
¹²Greenwood Trust, 971 F.2d at 821, 824-27, 831; In re Community Bank of Northern Virginia, 418 F.3d 277, 294-96 (3rd Cir. 2005). See also Discover Bank v. Vaden, 489 F.3d 594, 603-08 (4th Cir. 2007), rev’d on other grounds, Vaden v. Discover Bank, __ U.S. __, 129 S. Ct. 1262, 173 L. Ed. 2d 206 (2009).
¹³See 12 U.S.C. §§ 1463 (g) and 1785 (g). See also 94 Stat. at 164-66 (12 U.S.C. § 1730g was repealed and reenacted as 12 U.S.C. § 1463 (g) under the Home Owners’ Loan Act (HOLA)).
¹⁴See Yeomalakis v. FDIC, __ F.3d. __ (1st Cir. April 3, 2009); Gavey Properties, 845 F.2d at 521; 12 C.F.R. §§ 560.2 and 560.110.
¹⁵12 U.S.C. § 1751 et seq.
¹⁶See 12 U.S.C. §1757(5)(A)(vi); 12 C.F.R. §§ 701.21(b) and (c).
¹⁷See 94 Stat. at 167.
¹⁸See Laws of 1981, ch. 45, § 50.
¹⁹15 U.S.C. § 1601 et seq.
²⁰12 C.F.R. § 226.
²¹15 U.S.C. § 1601(a).
²²See 15 U.S.C. §§ 1605, 1606, 1631, 1632, 1637, 1642-45, 1663, 1666 to 1666j; 12 C.F.R. § 226 subpt. B.
²³See 15 U.S.C. §§ 1610, 1666j; 12 C.F.R. § 226.28.
²⁴See Labaton, supra; Lerer, supra; Two Legislative Approaches to Reining in Credit Card Companies, N.Y. Times, April 24, 2009.
²⁵See Marcy Gordon, House Passes Credit Card Bill That Helps Consumers, Associated Press, April 30, 2009.
²⁶See Truth in Lending, Final Rule, 74 Fed. Reg. 5244, 5397–5421 (Federal Reserve 2009), and Unfair or Deceptive Acts or Practices, Final Rule, 74 Fed. Reg. 5498, 5559–84 (Federal Reserve, OTS, and NCUA 2009) (modifying Reg. Z and Regulation AA of the F.T.C. Act, relating to certain unfair credit card and revolving credit practices, application and solicitation practices, and consumer disclosures).
²⁷See 1995 Wis. Act 328.
²⁸See LRB drafting file for 1995 A.B. 830.
²⁹See Mark Furletti, The Debate Over the National Bank Act and the Preemption of State Efforts to Regulate Credit Cards, 77 Temple L. Rev. 425, 425 (2004).
³⁰Id. at 441-43.
³¹Id. at 443.

Aaron R. Gary, Univ. California-Davis 1992, is an attorney with the Wisconsin Legislative Reference Bureau.